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RENEWED VOLATILITY TESTS TREASURERS

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The recent surge in foreign exchange volatility may be catching some corporate treasurers by surprise after the currency market’s prolonged lull.

“Over the last year and a half, volatility has returned [to the foreign exchange markets],” notes Karl Schamotta, director of FX strategy and structured products at Cambridge Mercantile Group. “We’ve seen the emerging markets run into troubles, and now the majors are adjusting quite dramatically, as well.”

Schamotta links the currency moves to “a rebalancing in the global economy,” as growth in China slows while economic activity in the developed world, particularly in the United States, picks up steam. “What we’re seeing is central bank policies, economic growth and simply the flow of capital—the expectations of those things are shifting in different directions right now.”

People have become well aware that the house is on fire again.

~ Schamotta, Cambridge Mercantile Group

A lot of corporate treasuries were relatively unprotected as they headed into the renewed volatility, Schamotta says, citing the low implied volatility on options on major currency pairs earlier this year. “Buying insurance on currency movements was relatively cheap,” he says. “That really reflected that there wasn’t a lot of demand, there weren’t a lot of people looking to protect themselves. Many corporates simply said, ‘Let’s focus on the underlying business and leave the currency markets to do what they will.’”

Whether companies cut back on FX hedging while volatility was subdued likely depended on each company’s policy, says Krishnan Iyengar, a vice president at treasury and risk management solutions provider Reval. Iyengar says that some companies give hedging managers the latitude to modify the amount of exposure they hedge. “A very common approach companies use is, they allow their risk managers a policy band to hedge within, depending on external market factors,” he says.

Nevertheless, any complacency among companies has now evaporated. “People have become well aware that the house is on fire again,” Schamotta says. “Treasurers are looking at putting trades in place. Unfortunately, the reality for many is that they’re reacting too late.” He adds that some people with large euro and yen receivables who had thought they were “sitting in the sweet spot” have taken substantial losses, while others are looking to lock in the gains they’ve achieved using forward contracts.